Organisational Structures and their Implications
Insurance companies can be broadly divided into four categories: stock companies, mutual companies, reciprocal exchanges, and Llyod's companies. The former two are the dominant forms of organisational structures in the US insurance industry. A stock company is one that initially raises capital by issue of shares, like a bank or a non bank financ¬ial institution, and subsequently generates more funds for investment by selling insurance contracts to policyholders.
In other words, there are three sets of stakeholders in a stock insurance company, namely, the shareholders, managers and the policyholders. A mutual company, on the other hand, raises funds only by selling policies such that the policyholders are also partners of the companies. Hence, a mutual company has only two groups of stakeholders, namely, the policyholder cum part owners and the managers.
As in any organisation, the objectives of the owners, managers and policyholders are significantly different, giving rise to conflicts of interest. Specifically, owners and managers are often more keen to undertake risky activities than are the policyholders, largely because the former have limited liability such that, in the event of an unfavourable outcome, the policyholders will have to bear the lion's share of the loss.
However, it is unlikely that in a company that the appetite of the owners and the managers will be similar, and this provides the owners with a rationale to monitor the managers. In principle, both the shareholders in a stock company and the policyholder owners in a mutual company have it in their interest to monit¬or, the managers.
But whereas stockholders can exit a company easily by selling its shares in the secondary market, thereby paving the way for a take over, the policyholder owners find it more difficult to exit because they then have to incur the informational cost of associating themselves with another (viable) company.
In other words, the threat of exit by owners, and the associated threat of overhaul of the incumbent management by the owners, is more credible for stock insurance companies than for mutual insurance companies.
Hence, policyholder owners of mutual companies are likely to allow the managers of these companies less operational flexibility than the flexibility of the managers in stock insurance companies. As a consequence, the mutual insurance companies are likely to be more con¬servative with respect to risk taking than the stock companies.
Alternatively, if an insurance company writes lines of business that do not require a significant amount of managerial discretion, then it might be profitable for the company to adopt the mutual ownership structure and thereby eliminate the agency conflicts that can potentially arise between the owners and the policyholders.
Insurance companies can be broadly divided into four categories: stock companies, mutual companies, reciprocal exchanges, and Llyod's companies. The former two are the dominant forms of organisational structures in the US insurance industry. A stock company is one that initially raises capital by issue of shares, like a bank or a non bank financ¬ial institution, and subsequently generates more funds for investment by selling insurance contracts to policyholders.
In other words, there are three sets of stakeholders in a stock insurance company, namely, the shareholders, managers and the policyholders. A mutual company, on the other hand, raises funds only by selling policies such that the policyholders are also partners of the companies. Hence, a mutual company has only two groups of stakeholders, namely, the policyholder cum part owners and the managers.
As in any organisation, the objectives of the owners, managers and policyholders are significantly different, giving rise to conflicts of interest. Specifically, owners and managers are often more keen to undertake risky activities than are the policyholders, largely because the former have limited liability such that, in the event of an unfavourable outcome, the policyholders will have to bear the lion's share of the loss.
However, it is unlikely that in a company that the appetite of the owners and the managers will be similar, and this provides the owners with a rationale to monitor the managers. In principle, both the shareholders in a stock company and the policyholder owners in a mutual company have it in their interest to monit¬or, the managers.
But whereas stockholders can exit a company easily by selling its shares in the secondary market, thereby paving the way for a take over, the policyholder owners find it more difficult to exit because they then have to incur the informational cost of associating themselves with another (viable) company.
In other words, the threat of exit by owners, and the associated threat of overhaul of the incumbent management by the owners, is more credible for stock insurance companies than for mutual insurance companies.
Hence, policyholder owners of mutual companies are likely to allow the managers of these companies less operational flexibility than the flexibility of the managers in stock insurance companies. As a consequence, the mutual insurance companies are likely to be more con¬servative with respect to risk taking than the stock companies.
Alternatively, if an insurance company writes lines of business that do not require a significant amount of managerial discretion, then it might be profitable for the company to adopt the mutual ownership structure and thereby eliminate the agency conflicts that can potentially arise between the owners and the policyholders.